The EU risks a very frosty winter as tensions in Ukraine rise

Oil prices rose again in Asia because of the crisis in Ukraine, where fighting between government forces with pro-Russian rebels have left dozens dead in the east, which is a key transit route for gas. A barrel of ‘sweet light crude’ (WTI) for July delivery gained 7 cents to reach USD$ 104.18 a barrel while the Brent price hit USD$ 110.3. The increases were prompted by the tensions in Donetsk following the results of Sunday’s presidential election, won by candy magnate Petro Poroshenko. Donetsk is the bastion of Ukraine’s pro-Russian population, resulting in dozens of dead combatants on both side and two civilians between Monday and Tuesday. Poroshenko has dismissed plans to visit Moscow to discuss the standoff with President Vladimir Putin, who, in turn called for an end to the government forces’ ‘punitive’ operation in the East.

The situation in Ukraine has added to the oil and gas risk resulting from recent developments in Libya, where there is a high risk of a resumption of fighting on a large scale. The oil and gas markets are reacting to concerns that a prolonged civil war in Ukraine, a transit country for Russian gas exported to Europe, disrupting exports and causing a surge in energy prices. The crisis in Ukraine has served as a reminder of the extent to which the European Union, where many of its member States are struggling to recover from recession, relies on Russian gas for survival: over 50 % of needs.

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Today, the European Commission, therefore, presented a new strategy for energy security, aimed at diversifying sources of external energy supply, modernizing the energy infrastructure and stimulating savings in energy consumption. Of these, however, diversification will be the main target. The EU plans to accelerate the diversification of external energy suppliers, especially for gas. Russia supplies 39% of the gas consumed in the EU, Norway 33% and the remaining 22% is imported 22 from North Africa (Algeria and Libya – which is wrought with its own supply risks. The EU could seek new supply routes, for example in the basin of the Caspian Sea, through the extension of the Southern Gas Corridor, the development of Mediterranean gas hub and more LNG supply sources.

The EU also plans to strengthen its energy independence through renewable energy and fossil fuels. Energy efficiency should be strengthened. However, the EU has little time and it must find short term as well as long term solutions. In the short term, the EU will have to carry out comprehensive risk assessments ahead of next winter in order to anticipate and provide mechanisms for relief, given that the scale of the tensions in Ukraine and Libya are more likely to intensify than to resolve. The EU may consider such options as increasing gas stocks this summer, reduce demand through the use of alternative fuels (a return to coal or nuclear in Germany…?), or releasing some of the current emergency stocks.

The energy risk emanating from Ukraine to Western Europe is high. Should, Russia shut off the gas taps to Europe, due to its concerns in Ukraine – especially concerns that Ukraine will be offered a fast track into NATO – almost the whole of the EU, except the Iberian Peninsula and the South of France (which is supplied from Algeria), would be affected in a direct way. Europe risks a very frosty winter 2014-2015, especially South-Eastern Europe where over 60-80% of gas supplies are Russian. Former Soviet Republics or Warsaw pact members – and current NATO and EU members – such as Poland and Romania may need to compensate as much as an 80% supply disruption.

Adding ‘fuel to the fire’, Gazprom President Alexei Miller has insinuated that China and other Asian countries are willing to pay a higher price for Russian liquefied natural gas, meaning that Europeans will have to adapt if they want to keep their LNG terminals full. Gazprom plans to squeeze every possible dollar out of the crisis in Ukraine, which has been exacerbated by Sunday’s elections – despite the defeat of the extreme right. Miller suggested that the significant differences in tariffs gas between Europe and the Asian markets has resulted in a shift of gas originally destined for EU export to be shifted toward the Asian market. Miller’s statements were delivered in a delicate geopolitical context; however, his warnings have some ‘bite’ because Gazprom and China’s CNPC have just signed a thirty year LNG supply deal that will surely herald a competition for Russian gas between China and the EU, which will ultimately have an impact on gas supplies in Europe. The suggestion, from the White House, that the US will be able to compensate for the loss of Russian gas remains rather fanciful, which further strengthens Moscow’s stance.